Sunday, March 17, 2013

Why Silver Is a Better Stock Rally Bet Than Gold

With all three major stock indexes flirting with new all-time highs, investors seem to be joining the rally with abandon. Despite the very real issues of sequestration, continued easy money policy from the Federal Reserve, and a weak employment picture, there are some positives that suggest the stock market's rally may have legs. Still, prudent investors look at the whole picture and use caution in their approach to trading, meaning that an allocation to precious metals is wise. While both gold, as represented by the SPDR Gold Trust (NYSEMKT: GLD ) , and silver, as represented by the iShares Silver Trust (NYSEMKT: SLV ) , have been on a multiyear rally, the industrial applications of silver make it a better play at current levels.

GLD data by YCharts.

The stock market's historic runOver the past few weeks, the Dow Jones Industrial Average has hit a series of new historic highs, and the S&P 500 is zeroing in on its own all-time high. Highs like this tend to entice investors into stocks as fears of missing the rally intensify. This type of rotation is often a strong contrarian indicator, but the news isn't all bad. As things stand, the S&P's current P/E ratio is more than 5% below the index's historical average of 14.8, based on data going back to 1968 from Thomas Reuters. In addition, with U.S. Treasuries yielding less than 2%, the average dividend yield for companies in the index was 2.19% as of last quarter; even with the run-up, stocks are offering more yield than government securities are.

In terms of the overall economy, U.S. manufacturing was unexpectedly strong in February as retail sales figures had a good showing. Factory output, which had fallen 0.3% in January, doubled expectations by increasing 0.8%. Last week's job's report also showed a marked improvement in the employment situation, but with the economy adding 236,000 jobs, the figure was still below the sustained 250,000 that economists believe are necessary for a recovery.

Potential pitfallsWhile these figures make the stock market look appealing, it's important to put them into the proper context. Bickering in Washington continues to intensify as the effects of sequestration are beginning to be felt. Some of the sillier debates have focused on the cancellation of White House tours and President Obama's golf outings, while 700,000 jobs remain in harm's way.

White House Press Secretary Jay Carney accurately described the cuts:

It's an unfortunate result of the arbitrary, across-the-board nature of the sequester cuts. That was the -- I use this term facetiously -- the genius in the design of the sequester: It was written in a way to make it terrible. That was the purpose. Republicans and Democrats alike wrote it that way so that it would be so onerous that it would compel Congress to take alternative action to reduce our deficit in a more responsible way.

Of course, the compromise has yet to occur, and this is putting the economy in jeopardy. The Fed's ongoing course of quantitative easing also means that inflation is a real concern and that much of the stock market rally can be attributed to the defense of risk assets by the central bank. Every rally contains its own special attributes, and this one is no different.

Precious metals are in an unusual positionWhile gold and silver have typically traded largely in tandem, the industrial aspect of silver is helping its appeal to outpace that of gold. Earlier this week, Barclays Capital lowered its price target on gold from $1,778 per ounce to $1,648 per ounce: "[D]ownside risks to the outlook have risen while upside catalysts have�receded. In the U.S., despite headwinds related to the sequestration, retail sales have been�strong, and, in turn, increasing confidence in the economy has weighed upon interest in�gold." A critical factor for the downgrade was the outflow of assets from ETFs like GLD, as the firm acknowledges that the "macro backdrop remains supportive for gold."�

On the other hand, in recent years the industrial demand from silver has risen to a range of 550 million to 700 million ounces per year. Industry insiders predict that this demand could rise to as much as 800 million ounces in the immediate term. Relative to available supply, this makes silver an attractive play independent of any safe haven or inflation hedge catalysts. The demand for the silver is outpacing its supply.

If the economy faces the major setbacks that are clearly lurking below the surface, thus making precious metals appealing for wealth preservation, silver still remains more attractive than gold. In a recent webcast, guru investor Jeff Gundlach explained that the "high beta" nature of silver relative to gold made it the more attractive play. Ultimately, while the stock market's strength has some positive characteristics, silver looks like a smart play at current levels.

Getting silver exposureThe best way to play silver for most investors is probably the SLV ETF, but there are other options. Silver Wheaton (NYSE: SLW ) , the silver streaming company, has a market-leading 800 million ounces of reserves. The company buys the production of various miners at a fixed, predetermined price, giving it significant leverage to changes in the price of silver. Unlike miners such as First Majestic (NYSE: AG ) and Pan American (NASDAQ: PAAS ) , Silver Wheaton isn't exposed to mounting production costs and environmental concerns. Last quarter, First Majestic led the industry in cost control and still faced significant declines. Pan American came under even more pressure with higher costs. Overall, Silver Wheaton and the SLV look most attractive under current conditions

If you're looking for a company whose success is determined by the metals market, but without involving itself in the risks of physically mining the metals, then Silver Wheaton provides a unique play on the future of silver. SLW chooses to finance the mining of silver; it has grown sales and net income every year since 2008 and also has increased competitive advantages over its limited peer group. To learn more about Silver Wheaton, click here now to access The Motley Fool's premium research report on the company.